Does Breaking The Support Line Mean Mr. Bond Is Truly Out Of Danger?

A wise man once taught me that most trades aren't necessarily "right" or "wrong" but are either in favor or out of favor.

A few posts back, Leftback (LB) took a strong stance stating that Mr. Bond chose to die another day and seems to have been vindicated. Hopefully, LB is sitting on a nice, hefty profit!

Another contributor, Macro Clown (MC) commented in his GBP post that he was a strong believer that duration has entered a long-term selloff, and bonds into a bear market. I happened to have and still continue to share MC's view.

Clearly, the clown's face has been ripped off, and I haven't faired so well myself - as you can see below, 10yr rates pierced that mythical 2.3% support level. With that said, I just want to remind everyone that this doesn't necessarily mean we are wrong - it could be that the trade is currently out of favor.

Holy technical support levels, Batman!

(It's a very clean break of support, but I would like to remind all veteran traders that technicals usually don't work when all the technicians are fixated on it - we broke 2.30, but now what? Everybody's and their mom's CMT see this trade. Instead of chasing, I'm looking for a reversal signal)

Although it might seem that all hope is lost on both the fundamental (the last few prints of missed PPI and CPI, poor manufacturing numbers, etc.) and technical fronts, I believe there are potential signs of relief. For example, one of the leading indicator assets that's been the harbinger to the move in US breakevens has been the move of base metals (specifically iron ore in China).

Iron ore has collapsed. Risk reward for this asset is no longer to the downside. If iron ore finds a bottom, that could spell the bottom for inflation and yields.

With that in mind, despite the doom and gloom concerning hard data - it is important to remember that unemployment is still historically low and ISM has been printing at the highest level in a few years. Some assets have held up okay, such as oil, during this sell-off. In the very short end, the market still thinks that the Fed is on track vs the beginning of the year (2 hikes). Inflation (PCE and CPI) have not shown sharp drop-offs either - I know they're slow moving. Nothing in the central bank rates realm has really changed other than psychology. Read: the short duration trade is out of favor.

These tidbits could offer clues of where inflation could go next.

With that said, there are a few gray swans that exist in the market: continuing escalation in Syria (I know - I was supposed to write about this but didn't), North Korea, French elections (suddenly a photo finish - this global election cycle has engrained the idea of never trusting polls in my psyche). DM equities could find itself on false footing and see a drop as well - be careful Harry Hindsight!

These are all valid and possible concerns that can force yields to shoot even lower.

MC wrote about the populist trade getting ahead of itself. We have been witnessing the reversal. Just keep in mind that we could get to the point where the reversal itself gets overdone.

Good luck, don't lose your shirt or your face.

Oh! By the way, I wanted to tell a quick fictional story/obituary that should serve as a lesson for traders of all ages and sizes.

There was once a court.

The court had a jester of the global macro nature and a monkey of the execution variety.

The jester had lofty ambitions outside of the court. All he wanted was to be left alone so he could read, write and trade in the macro world. The execution monkey was simple, always chopping wood and playing on his iPad. The jester thought he had ripped off enough faces with his short duration trade to earn himself immunity in the court.

Little did he know, the monkey would falsely brand the jester a heretic in the court just as the short duration trade roared back, causing the jester to lose more than his face. In one foul swoop, the monkey had killed the jester. Although the jester is currently pronounced dead, with any luck, he will be resurrected, make his return and get the last laugh.

Trades are never always right or wrong - just in favor or out of favor. Look alive out there and stay nimble.

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comments

At the start of the year my view was that bonds were oversold, but the primary trend had bottomed. Positioning for long for mean reversion into the middle of the year appeared to be a reasonable position to take A this juncture we seem to be en route towards a mean reversion target area ,but after that I think the risk reward for a directional call is flat and not immediately worth taking. The low rates for longer misread will have been closed up.

Gold is getting ready to do a quick fakeout. Those who did not catch the move off of 1250 launch pad may want to have a GTC order in 1273-4 area and rip the reward on the move above 1300. I'll be right there with you buying the pullback, it'll be quick, imo.

Thanks for the write-up DR. In my counterpoint to LB yesterday I forgot to mention commodities, which signal the direction in the economy that really matters to global growth -- China. Iron ore, steel, and copper up a bit today, which is a change. Thermal coal got whacked though. Arguably want to see those stabilize and move higher before shorting bonds. Liquidity in China is rolling over, which raises a yellow flag. See: https://blog.variantperception.com/2017/04/07/chinese-excess-liquidity-rolling-over/

Regarding technical levels, I agree that their breach doesn't in-and-of-itself mean the reflation trade is over. It's time to watch carefully. The breach certainly brought out lots of short-covering. If this was all just a positioning squeeze, the downward momentum should subside now that positioning is cleaner. If it doesn't, then it suggests there's something durable to this, e.g. that inflation is not going to cooperate with the Fed's hiking path. CPI, I note, did print terribly, even stripping out the phone BS. The underlying US economy though, seems to be fine, judging by IJC. And let's remember that Q1 has historically been a weak quarter, so we should be looking at a big sequential pickup in Q2, i.e. now.

Just read that Fillon's supporters are quite certain of their voting intentions with only 20% not firmly decided, so maybe my theory that they'll switch to Macron is bogus. However, of the voters saying they'll abstain, a majority are Republicans, so maybe the prospect of Chavez versus Le Pen will get some of them to the voting booth.

My guess is those who want to hold protection through the election have it by now (have already put on bund-OATs trades), while speculators are starting to take their profits today.

johno the late Fillon supporters (or his come back rather) are actually depleting Macron's base to the direct benefit of Melenchon

the way i see it the more they vote Fillon the more likely Chavez-le Pen duel becomesthen if they really vote Fillon strong (not likely), you get Fillon-le Pen second round but le Pen still wins

why? she has a hard left, 90bn SPENDING program with more civil servants hired while Fillon has (the right...) 90bn CUT program and a promise to axe 500,000 civil jobs there is no way the left votes for that no matter how much they despise le Pen

this is getting really tense. Yesterday a very big player got out of Europe via the most liquid Estoxx benchmark it is very rare that Estoxx leads over Dax and more so over Italian MIB and Spaning IBEX in a downturn

Nico G, that makes me want to buy more gold. Those who missed GDX breakout have the opportunity right now to buy this pullback, the backtest of the b/o area. It's important to point out that GDXJ never broke out and is now breaking down. Stay in the large cap best of the breed miners.

Heads up on CAD. Govt is looking to "gently" slow down housing prices. Lol, what could go wrong? Oil is adding insult to injury. USD/CAD above 1.36 goes into a vacuum all the way to Jan 2016 high. That would be a 1K pip trade :)

Good Stuff. Thanks for keeping this site alive through collective efforts.

Nonetheless, based on the years I have read him, Macro Man himself would quite sympathetic to such a bold technical breakout in bonds, as this. It might be possible that he would construct a counter narrative, but not the MM I have come to know. Still, a long bond plan late in a very very long credit expansion is not ridiculous by any means. Likewise, backwardization in VIX-land does not exactly spell a risk-on narrative. That said, SPX is seemingly bullet-proof...

We are watching a little exit rally take place in crude oil and other reflation trades this week. There might be a relief rally in rates early next week depending on the results of the French election, but it will be transitory.

The bounce will fail, as commodity prices continue to erode, and crude oil prices fall in response to overwhelming evidence of excess supply and (US) production. Oil will then drive inflation expectations (and by extension, rates) lower. For the time being at least, the Fed is probably out of the picture, and the continued political uncertainty in Europe this summer will keep German rates low, and therefore US-German spreads will remain commensurately high and make Treasuries an attractive investment.

Be wary of those late cycle employment metrics, guys, it's always a lagging indicator.

Heads up on ITB and XHB, possible double top (going back to 3/16/17). DHI leading the way down after stellar earnings. Players could be using this opportunity to sell to Johnny-come-latelys. Adding to XHB short.

A friend has been pointing me to some big data analytics of social media suggesting Fillon has a better shot than polls suggest. There are also all those fence-sitting Republicans who might vote for him, driven by worries a Melenchon/Le Pen 2nd round. So I bought some calls on the CAC yesterday. Not terrible timing, but a small bet.

I had taken off my EURNOK early this week, thinking we could see some volatility. Have we. Still positioning to be wrung out and a market that doesn't want to add risk ahead of the election => EURNOK got silly today, IMO. Sold some for my patient book. What a crappy currency though. Someone here joked about it being an EM currency. That's about right.

Actually got long some GBPUSD yesterday. First time I've gotten long since the flash crash. One day probably didn't wring out all the shorts. I've also been impressed with how it's traded despite the poor consumption-related data. The bear catalysts haven't been working. I figure it can fair OK through the French election, getting dragged up by EUR in a positive outcome and exhibiting some safe-haven properties in a negative outcome. UK polls are notoriously bad, but supposing May picks up a decent # of seats (60?), she won't be held hostage by the hard Brexit camp, freeing her to negotiate something better-than-dreadful, or so the thinking goes.

What are you making of the divergence between GDX and GDXJ? Is it something more idiosyncratic with juniors or is the fact that juniors are underperforming (by quite a margin, since mid march roughly gold + 7%, GDX +10% GDXJ +1.5%) telling of larger macro concerns? This will obviously inform the decision to play for reversion or keep a safe distance.

@AP, GDX is a stronger ETF based on holdings, 17 out of top 20 are US based (best of the breed) vs only 11 in GDXJ. Also, it's a large cap vs small and players have been parking their money in large cap this year. There have been large outflows in GDXJ lately and I think it's not worth fighting that trend right now. Agree, at some point the rising tide will lift that small boat as well, just don't want to make that my trading plan at the moment. Long GDX